Hong Kong consults on rules to restrict ILS to qualified investors

The Government of Hong Kong continues to make progress on its mission to bring insurance-linked securities (ILS) business to the Special Administrative Region, launching a consultation paper on the definition of eligible ILS investor, as well as minimum investment size guidance and penalties should these rules be breached.

The Hong Kong Special Administrative Region (HK SAR) of the People’s Republic of China has been targeting insurance-linked securities (ILS) activity for a number of years now, as it sought to establish itself as a venue for the issuance of catastrophe bonds and other reinsurance linked instruments.

The Hong Kong Government’s Legislative Council passed the Insurance (Amendment) Bill 2020 on July 17th and later said it was targeting a full introduction of the new ILS regulatory regime by the end of 2020 or early 2021.

Now begins the work of fine tuning the ILS legislation and regulatory regime to make it fit for purpose, with investor protection a current focus in this new consultation.

The paper looks to define what makes an investor eligible to allocate to ILS or reinsurance linked securities, setting out what constitutes a qualified buyer of such securities.

As ever, the sophistication of an investor is key in ILS, as the securities are not deemed suited to wide distribution to retail type investors.

Hong Kong’s consultation paper says, “Given the nature of the underlying risk of investing in ILS and the potential for substantial loss of investment upon the occurrence of a pre-defined trigger event, ILS are not considered to be financial products suitable for ordinary retail investors.”

The goal is to “confine the sale of ILS to qualified institutional investors by private placement,” the paper says, then laying out a list of types of entities, including investment management firms, to banks, insurance companies, multilateral agencies, and collective investment schemes.

Restricting the types of investors is not expected to have any material impact on the scope of investors in ILS, as “ILS are niche financial products which appeal mostly to sophisticated institutional investors with expertise in reinsurance underwriting,” the consultation paper explains.

In addition, the paper looks to define a minimum investment size for insurance-linked securities (ILS), another way to ensure the sophistication of investors accessing the ILS asset class.

Hong Kong proposes a minimum investment size of US $1 million or equivalent, saying, “Our objective is to set an investment threshold which will effectively discourage the sale of ILS or the “repackaging” of ILS for sale to ordinary investors, while minimizing any impact on the competitiveness of Hong Kong as an ILS domicile.”

Finally, the paper lays out proposed offences and penalties for selling ILS investments to unqualified investors, as they look to ensure retail investors are protected.

“Our policy intent is that the sale of ILS should be confined to qualified institutional investors by private placement, such that the interests of ordinary retail investors would be sufficiently protected,” the Hong Kong Insurance Authority explained.

Adding that it is, “Committed to promoting Hong Kong as a preferred domicile for the issuance of ILS,” and that the goal of the ILS activity is to introduce “a bespoke and streamlined regime on par with other ILS domiciles such as Bermuda and Singapore.”